Self Directed IRA Strategies & 2012 IRA/LLC Legal Update

Many investors are aware of the opportunities that are available with self directed IRAs. This article highlights the strategies being used by self directed IRA investors and addresses some important issues and some recent cases regarding the IRA/LLC strategy.

As most of our readers are aware, a self directed IRA can be used to execute “alternative” investments such as real estate, precious metals, private lending, or non-publicly traded stock, and the investment returns receive the same tax favored IRA investment treatment we are all familiar with when investing our retirement accounts into stocks or mutual funds (e.g. tax deferred growth with traditional IRAs and tax free growth with Roth IRAs). One of the commonly used strategies by self directed IRA investors is commonly referred to as an IRA/LLC (aka checkbook control LLC). The idea of the IRA/LLC is that the self directed IRA invests its funds into a newly created LLC and in return receives 100% (unless there are partners or more than one IRA) of the membership of the newly created IRA/LLC. The IRA/LLC typically establishes an LLC bank account to hold the IRAs cash investment and this account is managed by the IRA owner or an advisor/professional third party. The IRA/LLC then executes the transactions on behalf of the IRA and holds legal title or ownership to the IRA/LLC assets on behalf of its IRA owner. In many instances, the IRA owner serves as the Manager of the IRA/LLC and performs administrative and investment oversight functions on behalf of the LLC such as signing contracts on investments, managing the IRA/LLC checking account, and receiving income and paying expenses on behalf of the IRA/LLC and its investments.  There are lots of rules, such as the prohibited transaction rules, that an IRA owner needs to be aware of before investing their retirement account with an IRA/LLC and we routinely advise clients on these laws and issues. For example, the IRA and the IRA/LLC cannot make a transaction with someone who is prohibited to the IRA such as the IRA owner itself or his spouse, children or parents. See IRC § 4975. This would prohibit the IRA from purchasing a rental property from the IRA owner’s father.

The original case where the IRA/LLC concept was permitted by the U.S. Tax Court is known as Swanson v. Commissioner, 106 T.C. 76 (1996). In this case an IRA owner established a corporation that was 100% owned by his IRA and which the IRA owner subsequently managed. The IRS challenged the investment into the corporation as a prohibited transaction and the Tax Court ruled that the investment was not prohibited. For many years, this was one of the few cases addressing the IRA/LLC investment structure whereby an IRA is the owner of 100% of a newly created company. However, in 2011 and 2012 there were two additional cases whereby the IRA/LLC structure has been analyzed by the Tax Court and the structure was again recognized as a valid investment option for an IRA that does not constitute a prohibited transaction.

The 2011 case was Hellwig v. Commisioner, 2011-58 (U.S. Tax Court 2011). This case involved the creation of four 100% owned corporations by Roth IRAs. The IRS challenged the 100% corporations which were managed by the respective Roth IRA owners. In the Court’s ruling the Court referenced the prior ruling in Swanson and stated that a retirement plan may purchase 100% of a newly formed company because the company is not a disqualified person upon formation. Also, the Court further held that actions of the Roth IRA owner who was managing the Roth IRA owned corporation was not prohibited.

The 2012 case was Repetto, et al v. Commissioner, T.C. , Memo 2012-168 (U.S. Tax Court 2012). This case involved a husband and wife who owned a construction company. The husband and wife both created corporations owned 98% by their Roth IRAs and 2% by a partner. The Roth IRA owned corporations then performed services for the construction company owned by the Repettos. The Court ruled against the taxpayer in this case because the Roth IRA owned corporations were performing services to the Repetto’s own company when there was no legitimate business purpose for such services and the resulting transfer and payment for services. While the taxpayer lost the case, the Court’s ruling was very helpful in analyzing the IRA/LLC structure as the Court stated in its ruling, “ The [IRS] agrees that generally an entity in which substantially all of the interest is owned or acquired by a Roth IRA may be recognized as a legitimate business entity for Federal tax purposes. However, …the resulting payments [from the Repetto construction company to the Roth IRA owned corporations] were nothing more than a mechanism for transferring value to the Roth IRAs [since there was no legitimate business purpose for the services and payments].”

In summary, the IRA/LLC strategy has been recognized as a legitimate investment structure for an IRA in three cases before the U.S. Tax Court.  The strategy does not, however, allow the IRA investor to avoid the prohibited transaction rules or allow the IRA owner to unfairly shift income or assets from themselves personally to their IRA. While we’d never recommend a client use an IRA/LLC for these purposes it is important to understand that the IRA/LLC strategy is a valid and well recognized investment structure for your IRA and that your IRA is still subject to the prohibited transaction and income shifting rules.

For more information and a consultation regarding your particular situation, please call the KKOS law office at 435-586-9366.

What to Use?: A Warranty, Grant or Quit Claim Deed

When it comes to transferring property, such as our rental properties into LLCs and our personal residence into a Trust, it can be confusing understanding the differences between a Quit Claim Deed, Warranty Deed and other terms that may be thrown out.

Some states use the term “Grant Deed”, California being one of the most preeminent. The reality is that a Grant Deed can be used as a Quitclaim Deed OR a Warranty Deed. It essentially depends on the verbiage used inside the terms of the Deed itself. Bottom line- Make sure that you look at the language used in the deed itself. Don’t think that because you have a Grant Deed you have all of the benefits of a Warranty Deed. Here is a brief description of each type of Deed:

Quitclaim Deed

A quitclaim deed transfers whatever ownership interest a person has in a property. It makes no guarantees about the extent of the person’s interest. Quitclaim deeds are also frequently used when there is a “cloud” on title — that is, when a search reveals that a previous owner or some other individual, like the heir of a previous owner, may have some claim to the property. The transferor can sign a quitclaim deed to transfer any remaining interest.

Warranty Deed

A warranty deed transfers ownership and explicitly promises the buyer that the transferor has good title to the property, meaning it is free of liens or claims of ownership. Also, whatever the ‘title’ of the deed is you may use, check the verbiage in the deed itself to understand what warranties you may be making, if any. The transferor guarantees that he or she will compensate the buyer if that turns out to be wrong. The warranty deed may make other promises as well, to address particular problems with the transaction.

Our Recommendation

Always double check the ‘local’ state and county laws regarding the type of deed to use when transferring property and what the different types of deeds actually provide. HOWEVER, we generally recommend the Warranty Deed when transferring property to yourself, your trust, or your own company; because we want to make sure that the Title Policy and all of its benefits transfer to the Grantee of your deed.


Seller Financed Deals and Installment Sales

Selling property as an installment sale can be a creative way to sale property and can also be a good way to defer the payment of taxes. An installment sale is a sale where a part of or the entire sales price is paid in later years. If you finance the buyer’s purchase of the property instead of the buyer paying with cash or getting a mortgage, you probably have entered into an installment sale.


In an installment sale, you report your gain on the sale of property only as it is received. You are taxed on the part of the payment that is attributable to your profit. So, when you sale property on an installment sale you do not pay the taxes in the year you sale the property because you have not fully received payment. Instead, you pay taxes only as you receive payment.  To correctly report the taxes, you need to determine what portion of each installment payment is going to be taxable gain.


To do this, you divide your gross profit (selling price minus basis) by the contract price. For example, say you purchase a property for $200,000 and later sell it for $400,000 under seller financed terms. Since you purchased the property for $200,000, you have a basis of $200,000 (you would also adjust the basis for improvements, depreciation, and other factors) and a contract sale price is $400,000. This gives you a gross profit of $200,000 (contract price minus basis). You then divide your gross profit of $200,000 by the $400,000 contract sale price, which equals 50%. You then take this 50% and apply it to each payment to determine which portion of the payment is taxable. This makes sense because each payment you receive, in this example, equally consists of a return of your basis which is not taxable and a payment towards the gross profit which is taxable. Other factors should be considered in an installment sale but hopefully this helps illustrate the point.


The benefit of the installment sale is that you take a portion of the gain into income each year. This gives the advantage of deferring taxes over time and can also keep you in a lower tax bracket. The major disadvantage is that you do not obtain the sale proceeds immediately and as result you cannot invest them elsewhere.


How to Have a $20 Million IRA like Mitt Romney? Self Direct It And Invest in What You Know.

The Walls Street Journal reported on January 19th that former Massachusetts Governor and Presidential candidate Mitt Romney has an IRA valued between $20 million and $100 million dollars. The article speculates about how those earnings were made and eventually concluded that because there is now way he could have such significant returns in mutual funds or typical stock or bonds that he must have invested in companies that he was consulting and working with while running the private equity firm he founded called Bain Capital. In other words, he self directed his retirement account into investments with small companies that he knew.


There are two important lessons to be learned from Mitt Romney’s $20 Million IRA. First, you don’t have to settle for a select group of mutual funds when investing your retirement plan and you can self direct it into all kinds of investments allowed by law including small companies such as Gov. Romney. Other popular self directed options are real estate, or loans, or precious metals. A Romney campaign aide who was questioned about Romney’s investments answered that the tax treatment for Romney’s IRA “is the same for Gov. Romney as it is for every citizen of the U.S.”  This is true. Don’t feel trapped into investing your IRA or other retirement plan into the menu you get from your account custodian. Look to put your retirement account with a self directed retirement plan custodian who will allow you to invest in any investment allowed by law. Typical prohibited investments by law include collectibles, life insurance, s-corporation stock, and related family member transactions and others outlined in IRC 4975. All else is fair game.


The second lesson to be learned is that Gov. Romney’s IRA account success was a result of him investing in what he knew. Many of our clients express frustration in their retirement plan investments because they end up investing in mutual funds, bonds, or stocks that they have no idea how they will turn out and have no skill or insight that gives them an advantage in their investments. However, many of our clients who self direct their retirement plans have found success in investing their retirement plans into what they know. This could be real estate or a small start-up company. Keep your investment portfolio open to self directed retirement plan options and don’t feel trapped into the typical stocks, bonds and mutual funds. As with all investments, please consult with competent legal professionals before investing money. There are scams and bad deals out there and you need to make sure your retirement account is properly protected before you invest.


In sum, the rules for self directed retirement plan investing can be tricky but with the proper counsel and with good investment decisions you can be well on your way to a $20 Million IRA. If you’d like a referral to a self directed retirement account custodian or if you have questions about self directing your retirement account, then please contact us at the law firm at 435-586-9366.

What is Crowdfunding & How Can I Use It to Raise Capital?

The JOBS Act signed into law by President Obama in April created a new exemption from the Securities Act of 1933 for “crowdfunding transactions”. This exemption allows entrepreneurs to raise small sums of money from large groups of people without having to complete a securities offering with the SEC. The concept of crowdfunding is to loosen the restrictive securities laws so that new companies can raise small sums of money from large groups of people. By limiting the amount of money raised by each person the law limits each investors risk. Crowdfunding can be used to fund any type of business or venture including a real estate business or investment, a new movie, or a technology business. Popular crowdfunding portals include, kickstarter.com, earlyshares.com, and indiegogo.com.

In order to qualify as a “crowdfuning transaction”, the issuer of the investment cannot sell more than $1M of securities in a 12 month period. Additionally, the amount that can be invested depends on the income or net worth of the investor. For investors with net worth or annual income less than $100,000, they can invest the greater of $2,000 or 5% of their annual income or net worth. For investors with annual income or net worth greater than $100,000, they can invest up to 10% of their annual income or net worth not to exceed $100,000. There is no requirement that investors be “accredited investors” and anyone can invest at least $2,000 in a “crowdfunding transaction”.

In addition to the restrictions on the amounts raised, the transaction must also be conducted through a broker of “funding portal” that provides risk disclosures and other information to investors. A funding portal is a new system of exchange that has been used in recent years by many small companies but has only recently been recognized in law under the JOBS Act. A funding portal is defined as a person that acts as an intermediary in a transaction involving the offer or sale of securities for the account of others. There are a number of restrictions placed upon funding portals such as prohibitions on investment advice or recommendations, they cannot solicit offers or transactions, they cannot compensate employees based on the sale of securities, and they cannot hold, manage or possess investor funds or securities.  Funding portals must register with the SEC as a funding portal but they do not have to be registered as broker-dealer.

The SEC has 9 months from the signing of the act in April to adopt regulations and guidelines. Crowdfunding will be an important and commonly used funding mechanism for many new small businesses and should be considered as an option in every business or investment where the funds being raised are $1M or less.